Used and Useful Principle
| Industry | Utilities regulation |
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In the utilities sector, the Used and Useful Principle mandates that energy infrastructure must be actively utilized and provide tangible benefits to current consumers before those consumers are charged for related expenses. This concept serves as a cornerstone in the regulation of utilities.
Predating the prudent investment doctrine, this principle was legally confirmed in the Supreme Court case Smyth v. Ames, 169 U.S. 466 (1898). The Court connected the notion of property being used and useful with its role in public service when establishing rates. This ruling laid the groundwork that only assets serving the public interest are eligible to generate a return on investment.
By requiring utilities to demonstrate that their investments are both employed and beneficial, this principle restricts costs passed on to customers, effectively excluding obsolete or uneconomical assets from the rate base. It also curtails excessive utility spending aimed at inflating rates, thereby safeguarding consumers without addressing shareholder losses, which distinguishes it from prudency assessments.
Fair Value Doctrine
The decision in Smyth v. Ames introduced the concept that utility property valuation should be grounded in fair value: "The basis of all calculations as to the reasonableness of rates...must be the fair value of the property used for public convenience." For nearly five decades, this fair value standard directed how rate bases were determined.
The approach to rate base calculation evolved with Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944), shifting focus from fair value to prudent investment and emphasizing the "end result" over precise property valuation. Nonetheless, the used and useful criterion continues to play a vital role in assessing rate bases.
Construction Work In Progress (CWIP)
During 1967, projections for nuclear capacity through the year 2000 spurred numerous reactor construction projects. However, extended construction durations, significant inflation, and the 1973 Middle East oil crisis led to many cancellations at various phases.
To address this, CWIP was established, permitting utilities to incorporate construction expenditures into the rate base prior to project completion, thus circumventing the used and useful requirement. This mechanism allows recovery of costs incurred during construction.
In 1976, the Federal Power Commission restricted CWIP inclusion to utilities experiencing "severe financial distress," aiming to lower total project expenses and ultimately benefit consumers. Despite this intent, these advantages often accrue to future customers rather than those who bore costs during construction but may no longer be served.
When construction expenses are excluded from the rate base, they may still accumulate interest through Allowance for Funds Used During Construction (AFUDC), which is subsequently added to the rate base once the project is finished.